SECURITIES AND EXCHANGE COMMISSION
In the Matter of the Application of
HARRY M. RICHARDSON
For Review of Action Taken by
Registered securities association denied member's application to permit employment of individual subject to a statutory disqualification. Held, review proceeding is remanded.
Charles R. Mills, Kathryn A. Sellig, and Jon A. Stanley, of Kirkpatrick & Lockhart LLP, for Harry M. Richardson.
Marc Menchel, Alan B. Lawhead, Deborah F. McIlroy, Leavy Mathews III, and Jennifer C. Brooks for NASD.
Appeal filed: March 18, 2004
Last brief received: June 29, 2004
Harry M. Richardson ("Richardson") appeals from a denial by NASD of a member firm's application to continue as a member with Richardson as an associated person. The application was necessary because Richardson is subject to two statutory disqualifications: an injunction and a bar order imposed by the Commission with a right to reapply after three years. We base our determinations on an independent review of the record.
On March 4, 1999, Richardson settled a civil action filed against him by the Commission by consenting to the entry of an injunction against future violations of Section 17(a) of the Securities Act of 1933; Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder; Section 15B(c)(1) of the Securities Exchange Act of 1934,1 and Municipal Securities Rulemaking Board ("MSRB") Rules G-17 and G-19.2 Richardson also settled a related administrative proceeding without admitting or denying the Commission's allegations that he "in connection with two 'pool' municipal bond offerings made material misrepresentations and omissions pertaining to the size of the pools and the intended use of the bond proceeds, and advised the pools to purchase unsuitable securities."3 The Commission further alleged that Richardson "in connection with three land development municipal bond offerings made material misrepresentations and omissions pertaining to the value of the land, developer, and capitalization of the project."4 Pursuant to the settlement, Richardson consented to being barred from association with any broker, dealer, investment adviser, investment company or municipal securities dealer, with a right to reapply for association after three years.5
In April 2003, more than three years after the entry of the Commission's bar order, Emmett A. Larkin Company, Inc. ("Emmett Larkin" or "the Firm"), applied to NASD to allow the Firm to continue in NASD membership with Richardson as an employee. After obtaining an agreement from Emmett Larkin for special supervisory conditions for Richardson, NASD's Department of Member Regulation recommended that the application be approved. After a hearing, NASD's National Adjudicatory Council ("NAC") in February 2004 denied the Firm's application. The NAC based its decision solely on the municipal bond misconduct underlying both Richardson's injunction and the Commission's bar order, finding that misconduct to be so serious that readmitting Richardson would not be in the public interest or consistent with investor protection.
The NASD decision acknowledged the tension between the denial and Commission precedent in Paul Edward Van Dusen.6 NASD characterized the holding of Van Dusen as requiring, in cases where the Commission has settled an administrative proceeding involving the same misconduct that underlies a permanent injunction and has imposed a bar with the right to reapply after a specified time, that "NASD may not consider the underlying misconduct in a subsequent application by the barred person to re-enter the securities industry at the expiration of the limited bar." NASD decided to deny the Firm's application on the basis of the underlying misconduct, however, since it
strongly believe[s] that this guidance in Van Dusen fails to take into account properly the separate analysis in which NASD is charged with engaging when an applicant seeks readmission. It conflates two separate processes - the one in which someone is barred from the industry and given the ability after a period of time to reapply, and the separate process by which NASD is charged with the duty to evaluate whether an applicant can be permitted to function in a particular registered capacity consistent with the public interest and investor protection.
This appeal followed.
Our review of NASD's denial of the Firm's application is governed by standards set forth in Section 19(f) of the Exchange Act.7 We must dismiss Richardson's appeal if we find that the specific grounds on which NASD based its action exist in fact, that the denial is in accordance with NASD rules, and that those rules were applied in a manner consistent with the purposes of .the Exchange Act, unless we determine that NASD's action imposes an unnecessary burden on competition.8
The grounds on which NASD based its decision, Richardson's statutory disqualifications resulting from the injunction and the Commission bar order, exist in fact.9 Moreover, the record gives no indication that the proceeding was not in compliance with NASD rules.10 Whether NASD's application of its rules in reviewing applications involving certain statutorily disqualified persons was consistent with the purposes of the Exchange Act can be determined by applying the principles set forth in Van Dusen and our subsequent decision in Arthur H. Ross.11
Underlying much of NASD's argument is its characterization of Van Dusen as setting forth a rigid "exclusionary rule" that precludes NASD from considering all relevant factors in reviewing applications like the one at issue here. To the contrary, Van Dusen and Ross encourage analysis that looks at all relevant factors, including, among others, misconduct in which a statutorily disqualified person may have engaged since the misconduct that gave rise to the statutory disqualification, the nature and disciplinary history of a prospective employer, and the proposed supervisory structure to which the statutorily disqualified person would be subject.12
Van Dusen and Ross do not preclude consideration of the misconduct that led to the statutory disqualification and the bar with a right to reapply. Rather, these cases require that the misconduct be considered in an appropriate context and given appropriate weight. For example, the misconduct could be considered as forming a part of a pattern, or in evaluating how well the employer firm's proposed scheme of supervision was designed to prevent the type of conduct that had resulted in the bar order.13 Quite simply, Van Dusen and Ross instruct that an SRO ordinarily may not deny reentry based solely on the underlying misconduct that led to the statutory disqualification and the conditional bar; something more is needed.14
Thus, Van Dusen and Ross recognize that the misconduct underlying a statutory disqualification may play a role in the consideration of an application like the one at issue here.15 Requiring that NASD generally consider new information leaves ample room for NASD to consider a wide range of appropriate factors.16 Van Dusen and Ross neither force nor preclude any particular outcome.17
Specifically, Van Dusen involved an NASD denial of association to a person subject to two statutory disqualifications, an injunction and a Commission bar from association with a broker-dealer in a supervisory capacity, with a right to apply after 18 months.18 We set aside NASD's denial because it was premised on NASD's finding that the underlying misconduct that had led to Van Dusen's statutory disqualification was sufficiently egregious that Van Dusen's association would not be consistent with the public interest.19 We determined that the denial of the application on that basis was inconsistent with the purposes of the Exchange Act and unfair. We were careful to make clear, however, that such applications should not be granted automatically simply because the passage of time had made application possible; instead, a variety of relevant factors should be considered.20
Ross involved a person subject to statutory disqualification based on a Commission order that barred him from associating in any proprietary or supervisory capacity, with the right to apply after three and one-half years.21 NASD denied Ross's application to perform supervisory functions and become a principal in the firm that employed him. Although the record contained new information that perhaps reflected adversely on Ross's ability to function in his proposed employment in a manner consistent with the public interest, it appeared that "NASD also gave substantial weight to matters related to the Commission Order," and we could not determine the degree to which NASD's action was based upon the behavior that resulted in the bar order rather than the new information.22 Because we could not conclude that NASD's decision was consistent with the purposes of the Exchange Act, we remanded the proceeding. We stated that "our expressed policy in cases of this type . . . requires that the NASD generally confine its analysis to new information," but explained that the misconduct that led to a statutory disqualification could play a legitimate role in that analysis in appropriate circumstances.23
NASD does not attempt to distinguish Richardson's case from Van Dusen and Ross. It argues, instead, that Van Dusen (and implicitly Ross) should be overturned. NASD argues that the Commission "committed two fundamental errors" in deciding Van Dusen. First, NASD argues, the Commission "misread the relevant statutory provision when it imported the requirement [found in Section 19(e)(2) of the Exchange Act, 15 U.S.C. § 78s(e)(2)] that sanctions in [self-regulatory organization or "SRO"] disciplinary actions should not be excessive into its review of the application of a statutorily disqualified individual [under Exchange Act Section 19(f), 15 U.S.C. § 78s(f)]." Second, it argues, the Commission "incorrectly relied on its 1975 policy regarding disqualified individuals who apply directly to the Commission for readmission into the securities industry" because NASD has never adopted such a policy and should be allowed to follow its own policy, "which includes analyzing the seriousness of the misconduct that relates to a permanent injunction."
NASD misreads Van Dusen by arguing that Van Dusen erroneously applies a standard applicable to our review of sanctions imposed in disciplinary proceedings to the review of denials of applications to continue NASD membership despite the employment of a statutorily disqualified person. In Van Dusen, we discussed the remedial purpose behind disciplinary actions, but we did so in the context of explaining that, in determining a sanction in a disciplinary action, we engage in an analysis that determines the public interest by weighing the alleged misconduct and the need to avoid visiting unnecessarily harsh consequences on wrongdoers.24 The reference to disciplinary actions does not suggest that the same analysis used in disciplinary actions should be used in considering applications to associate. To the contrary, the reference acknowledges that an analysis of public interest requirements based solely on the underlying misconduct has already been performed and that an application to associate after the time determined to be in the public interest has expired requires a different analysis.
NASD correctly states that the policy quoted by the Commission in Van Dusen -- "When hereafter the Commission specifies a date after which [an] application [for re-entry] may be made, the Commission upon a proper showing will generally act favorably upon the application" -- originally appeared in a release that dealt with applications for association that were directed to the Commission itself, not an SRO.25 By relying on that policy in Van Dusen, however, we clearly indicated our view that it also was relevant in SRO consideration of applications to associate.26 As explained above, Ross expanded on Van Dusen by suggesting ways in which consideration of the underlying misconduct might appropriately be part of an SRO's process.
NASD also argues that Van Dusen was incorrectly decided because it inappropriately articulated a substantive fairness requirement. NASD contends that the purposes of the Exchange Act do not encompass such a requirement, but only basic procedural guarantees.27 We disagree. Congress clearly intended that the substantive fairness of NASD deliberations subject to the Commission's review; one of the goals of the 1975 Amendments was to strengthen the Commission's oversight of SROs.28 The Commission has an obligation to ensure "that [self-regulatory power] is used effectively to fulfill the responsibilities assigned to the self-regulatory agencies, and that it is not used in a manner inimical to the public interest or unfair to private interests."29 Among the Commission's responsibilities in reviewing SRO actions under Section 19(f) is to determine whether the rules of the SRO have been applied "in a discriminatory or unfair manner," i.e., whether the action is substantively fair.30
We also reject NASD's argument that Van Dusen and Ross are inconsistent with the anti-fraud purpose of the Exchange Act and with NASD's duty to protect investors from unreasonable risk by ensuring high ethical standards in the securities industry.31 Van Dusen and Ross are not inconsistent with NASD's duty to critically scrutinize applications involving statutorily disqualified persons with a view to protecting investors. Rather, they articulate an analytic framework within which to consider such applications.
NASD's arguments ignore the impact that allowing the conduct underlying a statutory disqualification to provide the sole basis for denial of applications like the one at issue here would have on the Commission's own anti-fraud and investor protection efforts. If persons contemplating settlements with the Commission know that SROs, through denial of reentry applications, may, in effect, routinely extend those persons' bar from the securities industry beyond the period after which the settlement would allow them to reapply, based solely on the misconduct leading to the settlement, the incentive to settle would diminish markedly. Thus, allowing NASD to ignore Van Dusen and Ross would undermine our ability to settle cases in pursuance of our anti-fraud and investor protection goals.32
NASD argues that Van Dusen and Ross, in providing guidance on which factors NASD should examine in statutory disqualification hearings, allow disqualified individuals to craft their applications "to take advantage of Van Dusen." We believe it is entirely appropriate for statutorily disqualified persons to look to our decisions in Van Dusen and Ross and to understand that, before an application to associate will be approved, they will need to demonstrate, among other things, a clean disciplinary history subsequent to the statutorily disqualifying event, and that they would be well-advised to choose to associate with a firm with a good disciplinary record and an appropriate supervisory structure. Moreover, since Van Dusen and Ross do not purport to provide exhaustive lists of factors, applicants must still formulate their applications as their specific circumstances require.
We hold that Van Dusen and Ross remain the appropriate standards by which NASD should evaluate Richardson's application.33 NASD did not conduct its evaluation of Richardson's application consistently with those precedents, instead focusing exclusively on the municipal bond misconduct underlying the Commission bar order against Richardson. Therefore we are unable to determine whether the denial of Richardson's application is consistent with the purposes of the Exchange Act, and accordingly we remand for further consideration not inconsistent with this opinion.
An appropriate order will issue.34
By the Commission (Chairman DONALDSON and Commissioners GLASSMAN, GOLDSCHMID, ATKINS, and CAMPOS).
Jonathan G. Katz
In the Matter of the Application of
HARRY M. RICHARDSON
For Review of Action Taken by
On the basis of the Commission's opinion issued this day, it is
ORDERED that the review proceeding of the application by Emmett A. Larkin Company, Inc. to employ Harry M. Richardson as a general securities representative is hereby remanded to NASD for further consideration.
By the Commission.
Jonathan G. Katz
Richardson argues that, because NASD "intentionally act[ed] in derogation of . . . controlling Commission precedent," i.e., Van Dusen, its denial of the Firm's application "cannot be deemed to be in accordance with NASD rules." Richardson does not specifically identify any NASD rule that has been violated, and this argument therefore appears to be an assertion that the denial was not consistent with the purposes of the Exchange Act. See infra.
Where an initial public interest determination was made by an entity other than the Commission, different considerations may apply. See Ross, 50 S.E.C. at 1085 & n.13 (NYSE settlement not binding on NASD); see also Stephen R. Flaks, 46 S.E.C. 891, 894 n.6 (1977) (upholding NASD denial of application to associate, even though Commission had granted approval, because denial was based on independent ground of separate NASD bar, rather than on Commission bar).
Rule of Practice 451 provides that we will consider appeals (other than those from initial decisions by a Commission hearing officer) on the basis of the papers filed by the parties without oral argument unless we determine that the presentation of facts and legal arguments in the briefs and record and the decisional process would be significantly aided by oral argument. NASD contends that oral argument is necessary because the important policy issues at stake warrant careful consideration that necessarily will be aided by oral argument.
We do not believe that NASD has shown that oral argument will significantly aid our decision-making process. The parties have thoroughly briefed the factual and legal issues in this proceeding, and their contentions are presented before us in a manner that have permitted us to fully evaluate and determine the matters at issue. Accordingly, the request of NASD for oral argument is denied.
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